The Panama Papers and a Troubled World Economy

And then there is China. China arrests and executes middle-level officials and businessmen for corruption with remarkable regularity. However, a number of top-level Chinese Communist Party officials, including top man Xi Jinping, have been implicated — or at least their relatives have been tied to shell companies set up by Mossack Fonseca. Almost one-third of the firm’s business came from China, and Chinese and Hong Kong residents are its largest clients. Until recently, private capital used to flow into China, but last year, the country suffered an outflow of $500 billion.

What does all this have to do with monetary ease and, in particular, with the quantitative easing policy pursued by the U.S. Federal Reserve? In the 1970s, easy money triggered a bout of high inflation: workers got wage hikes, which pushed prices higher and triggered demands for more wage hikes, creating an inflationary spiral. By contrast, the Fed grew its balance sheet by $4 trillion in the 2008–14 period, but wages stayed low, keeping inflation under wraps. Instead, extra money went into asset prices, creating speculative bubbles. In particular, commodity prices, spearheaded by oil prices, went through the roof.

Commodity exporters received a fabulous windfall. Oil-exporting nations lived high on the hog as oil prices averaged above $100 per barrel, but China in effect was also selling a commodity: its boundless supply of cheap, highly organized labor. China has been a major beneficiary of U.S. monetary ease. Since 2000 its cumulative trade surplus with the United States totaled $3.5 trillion as America’s ability to print dollars — and China’s willingness to accept them in payment for its exports — allowed Americans to consume more than they produced.

Demand from China helped inflation bubbles in commodity markets. Brazil was just one among a variety of commodity producers in South America, Africa and the Middle East that prospered over the past decade by selling to China.

Political Bargain

A substantial portion of the windfall inevitably trickled down to the population. China’s annual wages nearly tripled in the decade since 2006, and hundreds of millions of peasants who had been living in extreme poverty moved to the cities, bought consumer goods and put aside savings. Since the Tiananmen Square uprising quarter of a century ago, the government in Beijing has offered its people a bargain: we let you live better while you let us rule without asking too many questions.

A similar bargain was struck in Russia, Brazil, Venezuela and various other countries. Consumers enjoyed a rising standard of living thanks to the flow of money from commodities, while ignoring official corruption and bribe-taking. No one paid much attention to the fact that the prosperity was mostly the function of an unprecedented — and unsustainable — jump in commodity prices underwritten by the running of the printing press by the Fed and other major central banks. Billions of dollars were not invested into long-term, sustainable development; instead they were siphoned off to offshore accounts or went to pay for luxury real estate in New York, Miami and London.

Pumping money into the financial system by pressing a button on a computer, as world central banks have been doing for eight years, can’t go on forever. The Fed wound down its QE program between December 2013 and October 2014; not coincidentally, commodity prices plunged — for instance, oil fell to one-third of its value. In December 2015 the Fed effected its first interest rate hike in a cycle. The world economy, which has been stagnant over the past couple of years, is now starting to show signs of a downturn.

The Panama papers merely confirm what ordinary people in emerging economies are starting to realize: that they have been misgoverned and that their rulers have been mostly interested in stuffing their pockets. It suggests a period of considerable political instability (which we are already seeing in Brazil) as well as massive repression. Since the scandal broke, Putin has announced the creation of a National Guard that will have the authority to shoot protesters without warning.

The unprecedented period of monetary ease has also created a skewed distribution of wealth and incomes in industrial nations — especially the U.S.

Our politicians may not be as blatantly corrupt as their counterparts in developing nations, but there is a strong feeling that the super-rich are not paying back into the system that made them wealthy; that the financial services industry, which was bailed out in 2008 with taxpayer money, is failing the ordinary consumer while enriching those closest to the central bank’s printing press; and that corporations, while steadily growing profits as a share of national income, are not investing in the economy and are instead rewarding their senior management.

The presidential election has shown the depth of discontent with the country’s economic system and its political establishment. While no U.S. corporations, politicians or wealthy individuals have been named in the Mossack Fonseca leak, the papers confirm that the rich and powerful all over the world are gaming the system in their favor. Nor is it a foregone conclusion that there won’t be embarrassing revelations going forward: there are some 3,000 U.S. and 9,000 British individuals and entities among the firm’s clients. If only $8 trillion of offshore funds has come from developing nations, this means that some $13 trillion of the total sum on offshore accounts belong to residents of rich developed countries.